Mr. Right and Mr. Wrong own an antique store in a partnership. They share profits and losses equally and receive an annual salary of $50,000, as per the partnership agreement. Mr. Right travels the country buying antiques. Mr. Wrong manages the store. From time to time, they use some of the small items from the store merchandise for personal use. Mr. Wrong’s daughter is getting married, and she loves an antique piece that costs $5,000. Mr. Wrong makes the following entry on the books to record the transaction:
Debit Credit
Cost of goods sold
$5,000
Inventory
$5,000
How should Mr. Wrong have recorded the transaction?
What are the ethical aspects of Mr. Wrong’s action?
Mr. White (invested $20,000) and Mr. Black (invested $10,000) are in a partnership to run a marketing firm. They share profits and losses in the ratio of 2:1, which is also the ratio of their initial investment in the business. Mr. White manages the office but Mr. Black gets all of the contracts for the firm. It is his high profile that gets the contracts for the firm. At the end of the year, the firm has reported net income of $300,000, which was allocated in the ratio of 2:1, ($200,000 for Mr. White, and $100,000 for Mr. Black). On Dec 31, 20XX, Mr. White’s capital balance was $150,000 and Mr. Black’s capital balance was $100,000. Mr. White has withdrawn more cash from the business than his partner Mr. Black.
On Jan 15th, Mr. White discovered that the net income for the previous year was understated by $60,000. Mr. Black tells Mr. White that this net income of $60,000 should be shared in the proportion of their current capital balances. (Mr. White = 150,000/$250,000 = 60% = $36,000; Mr. Black = $100,000/$250,000 = 40% = $24,000). But Mr. White feels that the additional income should be shared in the ratio of 2:1 ($60,000 x 2/3 = $40,000 Mr. White; $60,000 x 1/3 = $20,000 Mr. Black). Who is correct? Why?
GAAP rules are clear about when a company needs to consolidate or not, but companies tend to find loopholes to circumvent this rule. GAAP clearly indicates that consolidated financial statements are “usually necessary for a fair presentation when one of the companies in the group directly or indirectly has a controlling financial interest in other companies: the usual condition for a controlling financial interest is ownership of a majority voting interest.”
Controlling financial interest means to own more/greater than 50% of the voting stock of another company.
Because of this “greater than 50% of the voting stock,” some of the companies have taken advantage of the criterior, causing serious problems in the business world. Companies were destroyed and with it, employees lost their jobs, their pensions, and 401Ks. So FASB had to make changes to GAAP for consolidations and issued new guidelines.
As a student of accounting, you must know these rules. Please research and discuss the new guidelines issued by GAAP for consolidating entities.
Give an example of a company that was involved in this kind of unethical behavior.